13th annual Municipal Finance Conference


13th annual Municipal Finance Conference


Islamic Sukuk Finance Can Help Meet Africa’s Infrastructure Gap

In a recent post about financing Africa’s infrastructure gap, I noted that Islamic financial instruments such as sukuk have been used to finance infrastructure projects in countries like Malaysia and Indonesia, and in the Middle East, and could attract investors from such countries. Islamic finance requires a clear link with real economic activity and transactions have to relate to a tangible, identifiable asset, which comes in handy in the case of infrastructure financing.

Nascent market activity seems to point in that direction and some African countries have already set the course toward a greater use of Islamic finance to fund their infrastructure projects. Earlier this year, Nigeria’s Securities and Exchange Commission approved new rules facilitating the issuance of sukuk. In September, the southwestern Nigerian state of Osun issued a local currency sukuk. The seven-year instrument which raised about $62 million from domestic pension funds and international investors, paid 14.75 percent in nominal terms (which is equivalent to about 6.75 percent in real terms given the prevailing 8 percent inflation rate). It received an A rating from a local credit rating agency and is expected to be listed on the Nigerian Stock Exchange. 

After the recent trend of Eurobond issuance by African countries, the Osun’s offering is sowing the seeds for more African sukuk.  Prior to Osun, only Gambia and Sudan had issued local-currency short-term domestic notes (Sudan sold local currency sukuk worth $160 million in 2012).  

Now, Senegal plans to issue a $200 million sukuk program in 2014 to finance infrastructure and energy projects.  The Islamic Corporation for the Development of the Private Sector (ICD) said that the Senegalese sukuk would be the first of a series of programs that would be offered to West African countries. The Central Bank of the West African States (BCEAO) has in principle agreed to allow banks in its eight member countries to use the Senegalese sukuk be used in repurchase operations.  Other countries such as South Africa, Nigeria, Senegal, and Mauritania have also plans to issue Islamic securities.

There are two lessons from the Osun offering.  The first is that African countries should continue to be innovative to fund their development needs. In this regard, developing a strategy to tap the large pool of money seeking Islamic financial products is good policy. There are about 600 Islamic financial institutions operating in 75 countries, and global Islamic financial assets stand at about $1.3 trillion with a growth rate in excess of 20 percent.  African sukuk issuers will be able to diversify their investor base and, as is the case for conventional sovereign bonds, help establish benchmarks for other domestic borrowers.  For investors, African sukuk are worth considering as they offer different geographic and credit exposures.

But a second lesson from the Osun issuance is that sukuk can help develop domestic capital markets, which is typically a difficult and long process. Osun has issued a local currency instrument which was rated by a domestic agency and placed to domestic investors. For years, Malaysia has used Islamic securities to grow its domestic bond market which is now the third largest in Asia after Japan and South Korea.  Malaysia’s total sukuk issuance in 2012 was $97 billion with a total outstanding stock of $144 billion as of end of 2012. In countries with a large Muslim population, there is a demand for Islamic securities and it makes sense for policy makers and the private sector to consider financial securities that can meet this demand. About half of Nigeria’s 160 million people are Muslim and Pew estimates that the Muslim population in sub-Saharan Africa, about a quarter of a billion (243 million in 2010), will increase to about 386 million by 2030. The challenge, however, is to set up the conditions for Islamic financial products to be attractive to all investors. There may be lessons from the evolution of socially responsible investment industry too. But Malaysia is again a good example and when I visited Kuala Lumpur a few years ago, I was struck by how one bank, which catered to Malaysians of Chinese origin, was very active in Islamic products because its non-Muslim customers demanded fixed-rate products instead of the conventional floating-rate mortgages. 

Zeti Akhtar Aziz, the governor of the Central Bank of Malaysia, recently noted that “Islamic finance is well-positioned to assume a much larger role as a competitive form of financial intermediation for supporting economic activity, and as a channel for enhancing greater global connectivity.”  Malaysia is still working to improve its Islamic financial markets and its focus is now on internationalization but its roadmap to building a stable Islamic financial sector that can finance inclusive growth is useful to Africa as well. It starts with developing the legal framework for Islamic finance and establishing sound regulatory and supervisory frameworks.